A blog about economics, finance, business and corporate governance. My background is in economics, with degrees from Columbia and Johns Hopkins. A career in international development, equity capital markets and as a corporate finance chief and board member lead me to think about events in a different way--hence the blog's name.

Friday, May 24, 2013

HP: Stairway to Heaven or Road to Irrelevance?

Opinions in the financial press seem to line up at both extremes today. Thus, headlines say things like,

HP's strategy is not sustainable;

HP has a big slog ahead;

Time is not on HP's side;

HP needs growth;

HP is mortgaging its future;

The bullish case for HP;

HP is still a real value.

The risk-reward ratio for HP in the short run is pretty uninspiring, with the dividend to give some comfort until revenue growth and real, as opposed to non-GAAP, earnings growth appear. Just as we noted for Best Buy, where we said vendors needed the company, we'd say that customers need HP. If it didn't exist, a company like it would have to be invented.

Yes, it has some legacy businesses, but so did IBM and surely Dell does. Cisco is slowly trying to reinvent itself, but it still derives the lion's share of its revenue from mundane products in the Internet plumbing. Lenovo and other PC makers? Not hardly, not now. Microsoft and Oracle? Quasi-monopolists who are also using their enormous cash flows to reinvent themselves also.

So, to beat the drums about legacy businesses for HP alone, one would have to be wearing blinders. IBM can't be the IT company for all shapes and sizes of commercial and governmental organizations.

Another interesting comment CEO Whitman tossed off in her response to a question went something like, "Dell trashed its quarter to move x86 servers." Yes, it did. In the end, besides clearing inventory, it does nothing for the company as it moves to privatization. After it goes private, how will Dell spend money on research and development, new classes of servers, and the things that all companies need to prosper in the watershed changes to a new definition of IT? The new owners will be focused on one thing only, cash for distribution and debt repayment. Dell may be the company on its way to irrelevance.

The Moonshot server line has been referred to by CEO Whitman in the last two or three quarterly calls. It's evident now why. She talks about the generational transformation in information technology underway as being the biggest in her career. The Moonshot server program is one pretty significant step for HP in addressing this change for and with customers.

So much has been written about data centers, but they too are in the midst of a major transformation, because of the different devices on the network endpoints and because of the rivers of different kinds of data being processed, stored and analyzed. An HP-funded white paper describes the new Moonshot 1500 platform as blade servers "on steroids." It is described as the first software defined server to run Internet scale applications. Clearly, this is the direction the company needs to go, and the project was green lighted in 2010.

The charter for the group was "to break out of HP's mainstream enterprise value propositions." This formulation is very encouraging, and clearly it was not a skunk works. The platform is now out in the market place. This probably reflects decisions by the new CEO to accelerate this project at the expense of others, and it seems like exactly where the company needs to go.

What are some of the risks? The company's board is still not worthy of an industry leader. The discussion with former board Chair Ray Lane, who rejected the advice of Dodge and Cox to step down, was embarrassing for the company; Mr. Lane was magnanimous enough to give up the Chair and deign to remain on the board. Remember, he is from the "Valley." Tone deafness has a high incidence rate in Silicon Valley.

Time isn't working against the company. Expectations are rock bottom, and valuations are appropriate. Rebuilding the balance sheet, improving cash flows, paying down debt and changing capital allocation will give the company plenty of capacity to weather competition and the IT cycle.

Share buybacks should soon have seen their day, provided the board doesn't push management to put another big program out there. If another program is announced, please go slow and leave it fallow. Reinvestment in initiatives like Moonshot and in core businesses are paramount. Research and development needs to drive differentiation of products and services. That's where the high returns are, not in chasing the share price for the benefit of short-term shareholders.

The mediocre board could also harm the company again in selecting and valuing acquisitions. Their massive incompetence speaks for itself. In this regard, a revival of the Autonomy flap could divert management time, but hopefully it goes away quietly, another legacy of board mismanagement.

I have a suggestion for the new board Chair, if the company can persuade him to accept: Mr. Bill George, the former CEO of Medtronic. I've followed his work at Medtronic, read his writings, spoken with and heard him speak, many times. He has the stature, experience, business acumen, and moral leadership qualities to help the CEO and management navigate their way to real value creation. I can't think of a better choice.